Tesla (NASDAQ:TSLA) has certainly given investors a wild ride this year. As of April 17, TSLA stock had gained over 108% from its recent low on March 18. It was at $361.22 then. Moreover, since the beginning of this year, it is up over 70%. This is quite a feat for a company with a market capitalization of $132 billion.
Maybe investors are happy about its recent production numbers. Tesla recently reported solid first-quarter numbers on April 2. The automaker produced 102,672 vehicles in the three months to March and delivered 88,400.
Deliveries are what counts because that is when the company gets paid from the customer. These deliveries were up 40% from the previous year, according to CNBC.
That is very impressive, especially since most of the world has been essentially in lock-down mode during Q1 2020. But that does not account for why TSLA stock is up so much this year. What is really going on?
Investors Are Taking The Long View
One of the reasons the stock is so high is because Model Y production started in January and deliveries began in March. This was significantly ahead of schedule, as the Y was originally supposed to begin in the fall of 2020, according to Tech Crunch.
Model Y is Tesla’s compact crossover vehicle. To put it simply, the company is basically counting on it to take off. For example, its base price is $52,900, whereas the Tesla Model 3 has a base price of $39,990 (the long-range version is at $48,990).
But more importantly, Tesla is counting on ramping up Model Y production because the crossover segment is far larger than the sedan market. Tesla’s production plans are already ramping up for the Model Y in the U.S, according to the Tesla dedicated site, Teslarit.com.
A Napkin Estimate of Potential Profits from the Model Y
How much money can Tesla make with the Model Y? Let’s make some simple assumptions, like on the back of a napkin.
First, let’s estimate that Tesla can eventually take 10% to 15% of the worldwide compact SUV market. According to CarSalesBase, almost one-quarter of all U.S. car sales are compact crossovers. That’s about 4.1 million compact crossovers as of 2019. Second, let’s assume the worldwide base is twice that number, or 8.2 million compact crossovers.
Therefore, based on these assumptions, Tesla is aiming to be able to deliver between 820,000 to 1.2 million Model Y cars per year. Next, let’s simply everything and assume that the operating margin for each car is 10% to 15%. That means that each car will produce profits of between $2,645 to $5,290.
We estimated Tesla will ramp up production to about 1 million cars on average per year. So that means it will book profits of $2.65 billion to $5.3 billion per year, just from the Model Y. And I could be way off on the profit margin, but I think using an estimate of 5% to 10% is conservative.
How to Value TSLA Stock
So at today’s market valuation of $132 billion, TSLA stock trades for just 25 times projected earnings (i.e., $139 billion divided $5.3 billion). From that standpoint, today’s $711 price for TSLS stock does not look that expensive.
Keep in mind I have not added in profits for the Model 3, the electric truck coming out soon, and all the other product lines at Tesla. Moreover, although Tesla booked an operating profit margin of 4.9% in Q4 2019, its EBITDA margin was much higher at 15.9%.
Let’s assume that over time, efficiencies from scale kick in. That could push the EBITDA margin at least 15% to 20% higher, to 19% or so. Therefore we can plug that in our model.
With one million Model Y’s at an average price of $55K per model, revenue would be $55 billion per year. So a 19% EBITDA margin would be about $10.45 billion. Let’s call it $10 billion to simplify things.
That puts TSLA stock on a price-EBITDA ratio of just 13.2 times (i.e. $139 billion divided by $10 billion). That is not cheap, but it also does not seem very expensive for such a fast-growing company.
What to Do With TSLA Stock Today?
What I have shown is that there is some basic rationale for the huge price rise in TSLA stock this year. Keep in mind, though, that Tesla still has to perform. For example, it will have to reach the 10 to 15% market share that I used in my simplified model for the stock.
In addition, it has to produce up to one million Model Y cars each year in this simplified model. That is a huge increase in the production capacity of the company. For example, in Q1, its first quarter to produce the Model Y, Tesla made just 87,282 cars of both Model 3 and Model Y (the Model Y was not broken out).
My point is there is a lot that Tesla has to live up to. But the market assumes it will happen, given how successful the company has been so far. Don’t forget, the market always looks forward.
So, if any of my basic napkin-model assumptions turn out to be too conservative, TSLA stock could end up being a huge winner even from here.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
